East Africa’s financial services set for consolidation and expansion

What are the recent trends in the East African banking industry? And what does the future portend for the sector in the region?

For perspectives on these questions, African Banker is grateful to the views of two highly-esteemed Nairobi-based banking professionals: George Mutua, managing director and chief representative officer for the Kenyan office of Société Générale, a French bank; and Elizabeth Ndungu, head of research at Genghis Capital Investment Bank.

As expected, Kenya, the region’s largest economy, dominates the sector. However, government policy there is perhaps the most stifling for the sector at the moment. The good news is that there are indications some of the measures might be reversed. The first is the capping of interest rates on commercial loans at 4% above the Central Bank rate by the Kenyan government. Another is the recently introduced 0.05% ‘Robin Hood tax’ on cash transfers of more than Ksh500,000 from 1 July; which halved daily interbank volumes in the first week alone.

(Robin Hood was a legendary outlaw in 15^th-century Britain who stole from the rich to help the poor. Similarly, a ‘Robin Hood tax’ aims to take more from the wealthy to ease the burden on those not considered affluent.) The proposed Financial Markets Conduct Authority in Kenya also adds to increasing concerns about over-regulation. There is probably a need for stiffer rules, though. For instance, 10 Kenyan banks are currently under investigation for accepting stolen funds. But stronger rules could be self-defeating if they end up weakening the ability of central banks to rein in erring banks.

Reformist Central Bank of Kenya (CBK) governor, Patrick Njoroge, put it bluntly: “The [Financial Markets Conduct] bill emasculates the central bank”, adding the CBK “is under attack”. Without a doubt, there is increasing political interference in the region’s central banks and indeed elsewhere on the African continent. Curiously, Tanzania’s President John Magufuli, well-known for his heavy-handedness, does not plan to bail out struggling banks in his country: “I will not give any money to failing banks,” Magufuli said in March this year, adding “it’s better to have a few viable banks than dozens of failing banks.” The recurring theme is clearly one where on the one hand, governments in the region are more overbearing on banks, with more regulations, while on the other hand, in the Tanzanian case, for instance, they are not so supportive of those that flounder.

Reduced profits, rising NPLs

Undoubtedly, top-of-mind amongst bankers in East Africa is the expectation that the Kenyan government would repeal the law capping interest rates. Since the legislation, credit has slowed. George Mutua says: “We expect the interest rate caps to be repealed through an act of parliament – sometimes in 2018. This should lead to more lending by commercial banks to the SME sector. Easier access to credit will drive economic growth and should improve GDP growth.”

Ordinarily, banks were increasingly loading up their books with government securities. The rate cap made doing so more a necessity than a strategy. Should the rate cap be abolished, SG’s Mutua believes “banks would invest less in government securities and more in the private sector.” The move would certainly be beneficial for banks’ bottom lines, with “interest margins to increase gradually as banks take more risk and charge relatively higher margins to the private sector,” Mutua adds. Genghis Capital’s Ndungu provides additional insights: “The banking industry in Kenya has experienced a challenging operating environment over the past year. This has mainly been attributed to interest rate caps introduced in the third quarter of 2016 that has seen banks record reduced profitability on account of reduced net interest income.

“In response to this, we have witnessed banks adjust their business models through a combination of initiatives aimed at reducing costs, such as cutting down branches, laying off staff and enhancing operational efficiency, coupled with revenue diversification so as to tap into non-funded income.” On interest rate caps, Ms Ndungu’s view is: “While the interest rate caps have been a pain to the banking sector in Kenya, the East African region has been grappling with increasing non-performing loans (17.4% in Burundi, 12.4% in Kenya, 8.2% in Tanzania and Rwanda, 6.2% in Uganda), primarily on account of the high interest rates in neighbouring countries and inadequate risk assessment, which could affect economic growth in the region adversely.

“Lending rates in Uganda, Tanzania and Rwanda range between 18% and 21%, which has seen borrowers suffer the full brunt of accessing credit and led to high default rates. This in turn has stifled private sector credit growth as banks enhance risk management to curb this trend.”

On NPLs, for Kenya at least, SG’s Mutua observes “no major shift in NPL levels considering that banks have been forced to clean-up their books and make provisions in good time by the Central Bank of Kenya”; however, he expects “credit growth in agriculture, construction, manufacturing, retail/FMCG, as banks come up with a lending mandate in support of President Uhuru Kenyatta’s Big Four agenda”.

Regional expansion & new entrants

Even as it is expected that the authorities would abolish interest caps in Kenya, they would continue to lean hard on banks who charge their customers disproportionately. SG’s Mutua believes there would be “stiffer regulation on how and what banks charge to borrowers with the Central Bank of Kenya insisting on transparency on the type and amount of financial cost”. Another development Mutua expects is “more consolidation in the banking industry – across the industry in the region. We still have too many small banks in Kenya, Uganda, and Tanzania and there’s a need for consolidation. It will be pushed by both business viability needs and regulatory requirements on adequate capital levels.

“We see the big local banks continuing to expand and deepen their presence across the region. Top local banks in Kenya, Tanzania, Uganda will start looking for regional dominance.” SG’s Mutua anticipates “the continued adoption of mobile-money and digital solutions by banks over additional/new investments in brick and mortar network and an increase of the agency banking model. Furthermore, there should be more and better market segmentation with a new emphasis on wealth management, financial planning solutions.”

On the outlook for NPLs and banking in the East African region, Genghis Capital’s Ndungu says: “Going forward, we expect this trend to be managed as banks fall in line with the requirements of IFRS 9 that requires a forward-looking approach in loan provisioning. “This will force banks to be more prudent in their assessment and will also require fiscal consolidation (government support) in order to ensure that private sector credit growth in the region does not deteriorate as a result of the crowding out effect.

“With a population growth rate of 3%, compared to other developed countries below the 1% mark, coupled with increasing financial inclusion and more uptake of financial services products, the East African region offers an appealing proposition for long term investors looking to take advantage of the attractive valuations.” SG’s Mutua also sees the “entrance of new global and regional players – the likes of JP Morgan want to establish a representative  office covering East Africa in Nairobi; the replacement of Barclays by ABSA in Kenya and Tanzania.” He also expects “more competition from local banks, empowered by mobile money solutions, agency banking, and digital banking – the ‘traditional’ local banks will pose new competition to established international brands in the region.”

In conclusion, Société Générale’s Mutua sees “more and better regulation of banks in Tanzania, in terms of how they classify and provide for bad debt in their books, more focus on supporting/financing intra-Africa trade as banks in East Africa target traders involved in exports and imports across Africa; better and stronger relationships with multilaterals, DFIs, insurance bodies, to put in place guarantees and de-risking solutions that will make certain sectors like agriculture and  commodity trading more bankable.”